How To Change From Sole Proprietor To Incorporation
A sole proprietorship is a business that is owned and run by a single person. All of the profits of the sole proprietorship belong to that person. Unfortunately all of the liabilities of this type of business also belong to you as the owner. A sole proprietorship is a quick and inexpensive way to start a business to test the waters. Once your business grows to a point where a sudden loss could irreparably damage your personal finances, it is time to upgrade to incorporation. This move will insulate your personal finances and make the business an entity unto itself.
Create a new corporation. Hire an attorney to help you through the creation process. Read More:What Happens to Assets in a Sole Proprietorship if it Changes to a Corporation?
Draft sales documents under the name of the old business. Transfer the ownership of the equipment, buildings, vehicles and all other physical assets of the old company to the new corporation.
Draft purchase documents under the name of the corporation. Transfer shares of the new corporation to yourself, the owner of the sole proprietorship, to pay for the assets being transferred.
Transfer employees from the sole proprietorship to the new corporation. Technically this process involves firing each employee from the old company and hiring each one at the new corporation.
Notify your clients of the situation. Change any existing contracts to match the name of the new corporation.
Check Your Business Name
When you are converting a sole proprietorship to an LLC, you need a unique business name. Your current business name might already be registered to another LLC in your state. If thats the case, you cannot operate as an LLC under that name, even if youve been using it as a sole proprietorship.
Check if the name is available by contacting your states secretary of state office. Many states have an online database for registered business names. You can also have a legal professional help you propose a name for your LLC.
Once youre sure no one in your state uses your business name, make sure it doesnt infringe on anyones trademark. Use the United States Patent and Trademark Offices database to search trademarks.
You must include Limited Liability Company in your business name. Or, you can use an abbreviation like LLC, Ltd., or Liability Co.
Usually, you dont need to register your LLC name. The name is automatically registered when you file paperwork to form the LLC. State rules differ, so double check with your state.
Pay And Establish Reserves For Financial Obligations
Your corporation’s formation state and the other states where it is registered do not consider your LLC completely dissolved or withdrawn until it settles all outstanding tax obligations for sales tax, franchise tax, income tax, and any state-mandated employee payroll deductions. Pay these and any federal taxes to finalize the dissolution.
State law also requires a dissolving corporation to set aside funds to pay any future corporate liabilities that are known to exist, such as a pending lawsuit or an obligation to contribute to an employee retirement plan. If the exact amount of the potential liability is uncertain, the reserved funds should represent your good faith estimate of the future payment obligations.
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What Is A Sole Proprietorship
A sole proprietorship is the simplest and most common business entity. As of 2010, there were more than 23 million operating in the U.S. A sole proprietorship is an unincorporated business with one person or a married couple as its owner.
While a sole proprietorship is a business entity, it is not a legal entity. Sole proprietors report business income and losses on their personal tax returns. They are solely responsible for any business debts or legal obligations. One of the pros of a sole proprietorship is how easy they are to establish. Typically, you dont need to register a sole proprietorship with the state, and you dont need to file separate taxes.
But because you dont register a sole proprietorship, your business name will default to your legal name. Youll need to file a DBA or doing business as to establish your businesss trade name.
While theyre easy to start and manage, sole proprietorships come with many legal, financial, and business risks. If somebody sues a sole proprietorship, the individual or couple who owns the business is personally responsible for any damages a judge awards. Additionally, sole proprietors often find it harder to get business loans or land big clients. They also have certain tax disadvantages compared to other business entities.
Are You Planning To Start Providing Extensive Fringe Benefits
Corporations enjoy many tax benefits and one of those is that they can deduct the full cost of fringe benefits such as health insurance and reimbursement of medical expenses that are provided to their employees. Employees also dont have to pay any tax on the value of these fringe benefits.
There are many different kinds of business structures in Orange County, California that can also deduct the cost of various fringe benefits as a business expense. If you are planning on adding health insurance and other fringe benefits for your employees in the near future, you need to consult with a business attorney on what business structure should you convert your company into.
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Pros And Cons Of Incorporating A Sole Proprietorship
In a sole proprietorship, only one person owns the company. The owner doesn’t pay corporate taxes on any profit but instead reports it on their personal income tax return. Some advantages of this business type include fewer regulations, less paperwork, simpler tax returns, and one profit beneficiary.
There are many advantages of incorporating a sole proprietorship besides separating your personal assets from your business, including:
- Your personal assets are not at risk if there is a company lawsuit or bankruptcy. Note that you may want to consider business liability insurance because there are some cases in which you might be liable.
- Corporations offer tax savings, which varies depending on the profits your corporation is realizing.
Check Eligibility For S Corp Status
To elect S corp status, all of the following must be true of your company:
- Form 2553 was filed on time by an eligible business entity. Eligible business entities include corporations, LLCs, and partnerships, among others.
- Your company has no more than 100 shareholders.
- Your company has issued only one class of stock.
- Every shareholder has consented to the S corp election.
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What Do You Need To Incorporate Your Business
When you incorporate, it may be wise to hire a professional accountant to oversee the financial side of the registration process, as well as a lawyer to counsel you on any legal requirements. In that case, save at least $1,000 $2,000 for these costs alone.
You may also have to provide these documents during and in the years that follow the registration process :
- Articles of incorporation
- Yearly information returns
- Various corporate records
- Annual corporate tax returns and financial statements
- Payroll remittances and filings for corporate employees
- GST and/or HST filings
- At least one NUANS or CIDREQ name search report to confirm that your company name is not already taken.
Although you can do all this online through the Government of Canada website, there are also many physical outlets and business web portals in every jurisdiction where you can register for provincial or federal incorporation.
What Happens To Sole Proprietorship When Owner Dies
If you own a sole proprietorship, your business and your personal assets are considered one and the same for most legal purposes. As a result, when the owner of a sole proprietorship business dies, although your executor can sell the assets of the business, the business itself also dies, in a sense.
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Other Points To Remember
Incorporating your business is an exciting step, but the process can become complicated. It is particularly important that you properly document each phase of the process. Therefore, it’s recommended that you consult an attorney to help you with closing the sole proprietorship and creating the corporation.
Some other points to remember for your new corporation include:
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Lower Corporate Tax Rate
The second item I want to discuss is a lower corporate tax rate. In Ontario, the corporate tax rate is 15% combined with federal taxes. That means that any profits up to $500,000 in a year are taxed at only 15%, whereas personally you could pay up to 53% on your profits. The variable is huge, I would rather pay 15% of corporate taxes than 53% personally, especially on funds that Im going to be saving.
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Set Up A Business Bank Account
LLC owners must maintain a clear separation between their business and personal finances. Doing so shields their personal assets from the businesss liabilities. Also, it helps keep business records organized for tax reporting purposes.
After a state approves an LLCs Articles of Organization and the IRS issues the LLC an EIN, the business owner must set up a business account for the newly formed LLC. An LLC may not use an existing business bank account that was set up for a sole proprietorship.* This also applies to credit cards so that the correct legal entity name is associated with accounts.
Banks help entrepreneurs through the process of closing their sole proprietorships bank account, opening an LLC bank account, and moving existing business funds from the old account to the new one.
*Sometimes, sole proprietors dont even open a separate bank account for their businesses and use their personal bank and credit accounts instead. While thats legal, its not advisable! If the IRS were to audit the business owner, it might be difficult to produce accurate financial transaction documentation.
What Is A Business Structure Change
A business structure change occurs when one legal business structure replaces another legal business structure to contract for and perform licensed work. These changes require applying for a new license for the new business entity.
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A business structure changes when an individual/sole proprietor creates a limited liability company or corporation to handle his/her licensed business/contractor activities.
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A business structure changes when a business entity is liquidated and the owner revert to an individual/sole proprietor, or create a different legal business structure .
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Get Business Licenses And Permits
You need to register new business licenses and permits for your LLC. Check with your state to find out which licenses and permits apply to your business. Licenses you might need include a business license, sellers permit, and zoning permit.
You must apply for a new Employer Identification Number with the IRS. This is true even if you already have an EIN for your sole proprietorship.
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When Your Business Becomes Incorporated
Your legal status can change in one of the following ways:
- from sole proprietorship to corporation
- from partnership to corporation
When you change your legal status to incorporate an existing business, you need to do the following:
Step 1
You must contact the appropriate incorporating authority and register a new corporation, even though you already have an existing BN.
If you are incorporating with Innovation, Science and Economic Development Canada or one of the provincial incorporating authorities listed on Canada Revenue Agency registration and other provincial or federal programs, the following will apply:
- a new BN will automatically be registered with the CRA for your new corporation
- a new Corporate Income Tax program account will automatically be associated to the new BN
- skip step 2 and go to step 3
Step 2
Once your incorporating authority has provided you with your new incorporation information contact the CRA at 1-800-959-5525 to register a new BN. A new RC program account will automatically be associated to the new BN. During the same phone call, follow step 3.
Step 3
Once the new BN has been registered with the CRA, any program accounts that are associated to your old BN, such as GST/HST program account or payroll program account will not be automatically associated to the new BN.
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What Is A Corporation What Is An Llc
A corporation makes your business a distinct entity. In other words, it separates your business assets from your personal assets. Worried because you are the only person in your company? That is just fine one person or multiple people can own a corporation.
In most cases, if you are considering incorporating your small business, you will want to investigate S corporations. These are corporations especially designed for small businesses. S corporations are not usually required to pay corporate taxes instead they only pay taxes on dividend earnings. Growing fast? Want to issue stock? A C corporation will allow you to issue stock and set up a board of directors, but you will have to pay corporate taxes.
An LLC, a Limited Liability Company, is a different type of business entity. Like a corporation, an LLC offers protection for the owners’ personal assets in the event of a lawsuit or debt. The ownerscalled members when the firm is an LLCcan collect their profits through the company without paying corporate taxes in many states. There is also greater flexibility in how profits can be distributed amongst the owners than in corporate structures.
What Happens To The Current Business/contractor License Or Certificate
In most cases the license, certificate or registration becomes inactive and replaced by the new business structure. Exceptions are:
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Plumbing contractors because the license number is held by the master plumber or restricted master plumber associated with the plumbing contractor.
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Water conditioning contractors because the license number is held by the water conditioning contractor.
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Certified pipelayers because there is no license number issued to businesses that file a plumbing contractor code compliance bond to install water and sewer lines external to building structures.
Licenses and certificates issued to business entities required to obtain and file a bond are inactivated and a new license or certificate issued to the new business entity.
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Apply For An Employer Identification Number
All new corporations must apply for an Employer Identification Number from the IRS. You can apply online for free in a few minutes. Think of an EIN as a Social Security number for your business. Youll need this number to file your taxes, apply for business loans, open a business bank account, and more.
Converting A Corporation Or Llc To A Partnership Or Sole Proprietorship
Often, the simplest way to convert a business is to dissolve, and totally liquidate the assets of, a corporation or LLC, distributing the assets to shareholders and/or owners. Sole proprietor status is conferred immediately upon beginning business, while Partnership hinges on the Partnership Agreement being signed. Check with your Secretary of State to find out the exact process, because you may be able to convert to a different business entity instead of dissolving it in some cases.
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Changing From A Sole Proprietorship To Anything Else
Since you become a sole proprietor by default when you start doing business as an individual, you change a business entity by simply forming a new business entity and contributing capital. For partnerships, this process can be as simple as signing a Partnership Agreement, while more advanced business organizations, such as Corporations , or Limited Liability Companies, will require more effort and paperwork. At a minimum, Articles of Incorporation or Organization will have to be filed with the appropriate state authorities. Corporations must also establish and conduct a formal meeting of shareholders, while LLCs are often less strictly regulated.
Create An Llc Operating Agreement
An operating agreement designates how your LLC is owned and structured. Although you dont have to have an operating agreement, it is recommended that you obtain one in order to lay out specific procedures for management, voting, capital contributions, distributions, membership changes, and dissolution.
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Transfer Corporate Assets And Liabilities To Yourself
Your corporation is the legal owner of your business assets. This includes land, buildings, equipment, inventory, supplies, trademarks, customer contracts, cash-on-hand, and accounts receivable. It is also the legal owner of your business liabilities, including real estate leases, vendor contracts, software licenses, bank and credit card debt, and taxes. Since the sole proprietorship will be owned by you directly, everything owned in the corporation’s name must be transferred to you as part of the company’s liquidation.
This sounds simple, but the details are often complicated. For example, any real estate owned by the corporation can only be transferred to you in a formal closing that involves the filing of a deed, a refinance or payoff of the mortgage, and buying a title insurance policy. Any bank loan or contract that the corporation signed cannot be assigned to you without the bank’s or the other contract party’s consent. Oftentimes in business, changing needs and trends make scaling back a wise option. Converting a corporation to a sole proprietorship can be a complicated process.
This portion of the site is for informational purposes only. The content is not legal advice. The statements and opinions are the expression of author, not LegalZoom, and have not been evaluated by LegalZoom for accuracy, completeness, or changes in the law.
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